While not widely known, binary options trading can ideally be used as a tool to hedge forex trading. Instead of using a conventional stop-loss strategy to protect against any losses incurred, binary options trading on the other hand can prove to be highly beneficial for forex traders. The justification lies in the fact that when you trade binary options, it has proven to be a more lucrative strategy than stop-losses. In forex trading, stop-losses are generally risky when trading below the breakout point, whilst assuming that is where the stop losses are placed, and generate losses when they are hit.
On the contrary, utilizing a binary option hedge strategy, which is nothing but placing a position to win in the opposite direction of the trade, investors are in a better position to protect their losses through hedging than with stop-loss. The reason being that because if the trade fails than the options hedge wins, thus fully hedging the position thus resulting in zero losses even during failed trades. Investors can utilize this hedging strategy which helps to shift the risk from below the breakout point within the area between the breakout point and the stop-loss, to above the breakout point and in the area between the breakout point and the cost of the trade.
Smart investors use binary option hedging to protect against breakout failure of some major currency pairs such as USD/CHF or the AUD/USD. Generally speaking, within the hour after breakout, both the aforementioned instruments test their breakout points. When placing a conventional stop-loss the trade may succeed if it is correctly placed which is nearly impossible to fathom as to how far below a breakout point a test may descend. This volatility often shakes out of the position before breaking out again shortly afterward.
In such a circumstance a binary option hedge is useful. Immediately after placing the Forex trades at the breakout points, a USD100 hedges can be placed. As a result, investors can completely cover up to USD70 of their losses when the breakouts are tested. A noticeable point to mention is that had the breakouts truly failed the investor would have exited with zero losses as the binary option trade would in rather than losing money if a stop loss was used instead. Given the fact that the breakouts succeeded after testing the breakout points, investors can look to some profits as soon as they make more than USD85 (the amount lost when the binary option fails)on the Forex positions.
It must be noted that not all brokers allow their investors to hedge. In such a scenario, it has proven to be advantageous that optionFair allows for its traders to invest in both sides of the asset being traded, in other words, hedging.
The advantage of this hedging strategy relies on the properties of the trader’s momentum. Since nearly all investors utilize stop-losses below the breakout points, testing the breakout point can be quite a risky proposition especially when trading below the breakout point where more and more stops are hit and the momentum builds on the selling side. The same is true after the breakout test, when the breakout occurs again. At this point most traders are aware that the breakout did not fail and re-enter with greater momentum. This helps us quickly recoop the $85 loss of the original trade. You can see this in the image provided, as well as in my previous posts using the GBPUSD.
In conclusion, by using binary option hedging we shift the risk from below the breakout to above. This allows us to take advantage of trader momentum which works against us when using a stop-loss and works for us when using binary option hedging.